Tax reform is nightmare Déjà vu for Puerto Rico

As Congress sets its sights on passing tax reform legislation, members and Senators still have not dealt with how this major overhaul will affect the U.S. citizens of Puerto Rico and the island’s manufacturing sector that is so critical to its economy and future. If left unaddressed, this gaping hole could soon become the last nail in the coffin of Puerto Rico’s economy. The reason is simple, in both the House and Senate versions of the tax legislation, Puerto Rico is considered a foreign jurisdiction for the purposes of a new 10 percent minimum tax on U.S. companies’ overseas profits as well as a 20 percent tax on imports (in the House version) and a 12.5 percent tax on intangible assets (Senate bill). Puerto Rico’s manufacturing sector, which represents nearly half of the island’s GDP, could lose an additional 250,000 manufacturing jobs which would decimate the already beleaguered economy to a point of no return.

In the 1990s, congressional leaders and President Clinton wanted to balance the budget. Back then, policymakers thought that ending “corporate welfare” was a smart way of producing new revenues for the Treasury. On the surface this might not seem like a preposterous idea. The problem is that one of the most successful economic engines for Puerto Rico was targeted instead. When Congress decided to phase out Section 936 of the Internal Revenue Code, the thinking was that U.S. manufacturing companies operating in the island would finally pay their “fair share” of taxes and the federal deficit would be significantly reduced once those tax credits expired. At the time, many warned administration and congressional officials that the revenues would not come in and that thousands of jobs could be at risk.

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History proved them right, unfortunately. Not only did the new income never materialize, but American manufacturing plants in Puerto Rico left or reduced their operations, costing more than 100,000 jobs for the US citizens in the island.

Did these jobs come to the continental U.S.? No. They went to Singapore, Ireland and other foreign countries. When the tax credits phased out completely in 2006, the current economic depression started in Puerto Rico and has not abated since. The jobs were lost, the revenues that the Commonwealth earned from the economic activity and the deposits of these companies in the island’s banks were also gone. This triggered the massive exodus of Puerto Ricans to the states – to the tune of 600,000 plus and counting. In fact, 156,000 more Puerto Ricans have migrated to Florida alone in the aftermath of Hurricane Maria. Puerto Rico’s fiscal and economic crises are due to several factors, the most crucial one being the loss of federal tax incentives for U.S. manufacturing.

Several years later, we are faced with a similar debate. Only this time, a man-made perfect storm could be the death knell of the Puerto Rican economy. At a time when Congress is appropriating significant amounts of money to rebuild Puerto Rico after the devastation wrought by Hurricane Maria, it is counterintuitive to rebuild while at the same time crippling what’s left of the island’s lifeblood – its manufacturing sector.

In the rush to approve a significant piece of legislation, Congress needs to ensure that it includes language specifying that Puerto Rico should be considered a domestic jurisdiction for the purposes of these new taxes on U.S. multinationals abroad. Congress created base erosion in Puerto Rico by phasing out 936 which also helped foster the recession and deficit financing which led to the ongoing debt crisis. Now Congress, ignoring recommendations by the Congressional Task Force on Economic Growth in Puerto Rico and by the Senate Finance Committee’s report on international tax reform, is about to double down on base erosion in Puerto Rico. Congress should instead provide for policies that help attract jobs and investment to grow the economy in Puerto Rico so that the island is less dependent on federal aid and can better compete with low cost foreign jurisdictions for new investment and manufacturing jobs.

Senators and members of Congress should not send the tax reform bill to the president’s desk before addressing this pressing issue. History has shown what the consequences would be if Congress ignores this lesson.